Streetwise Professor

Today is Milton Friedman’s 100th birthday.  I consider myself his intellectual grandson.  He was the thesis advisor to my thesis advisor (Lester Telser).  There is a strong degree of affiliation between his views and mine-not surprisingly, since he decisively shaped the intellectual environment that shaped me.

Even though he has been dead six years, Friedman remains an influential figure-and a polarizing one.  Indeed, the financial crisis and subsequent economic turmoil have intensified the battle over his legacy.  Today you can find numerous encomiums to Friedman today.  But to many, he personifies the capitalist or “neo-liberal” ideology that wreaked economic havoc.  The controversy over the Milton Friedman Institute at Chicago, right at the height of the crisis, is one example.  Or Naomi Klein’s screed Disaster Capitalism, which identifies Friedman as the main intellectual architect of said disaster.

Part of the reason that those on the left feel free to bash him is because he isn’t around to defend himself or his views.  And the fact that he was so effective as both a scholar and a polemicist is part of the reason he is so despised on the left.  He got in their heads in the 60s and 70s, and has never left, even though he has departed this earth.  Almost singlehandedly he challenged the professional consensus within economics (the reigning Keynesian orthodoxy) and the political consensus throughout the country (big government liberalism), and although he did not vanquish either, he certainly put them on the defensive.  He debated and wrote and argued prolifically and tenaciously, and like some modern David slew many Goliaths.  His main adversary at the time was Paul Samuelson.  Yes, Samuelson was a great economist, but he is not remembered today either in economics or society at large the way Friedman is.

The sad thing is that the left routinely excoriates Friedman as inhumane, when he was in fact anything but.  He passionately believed that liberty was good for its own sake, but that it was the best way to alleviate human misery and encourage human development.

I wish Friedman had lived to comment on the financial crisis of 2008, and the slow motion crisis in Europe right now.  I am sure that he would have given those who lay the blame for these at his feet (and those of his intellectual and political acolytes) more than they could handle.

Happy Birthday, Milton.  You are missed, but your influence lives.  Everyone passes on, but the ideas of a select few live on far after their passing.  Milton Friedman is one of those few.

Timmy! is in Europe, to lecture the Europeans (yet again) on the need to get their house in order.  After all, his trips have been so wildly successful before, in the same way as Rodney Dangerfield shows were wildly successful.  Or in the same way as Geithner’s “very tough” action on Libor took care of that problem.

His trip has a special urgency now, because Obama fears that economic “headwinds” from Europe will interfere with his reelection prospects.

Germany’s finance minister, Wolfgang Schäuble, has been known to give Timmy! verbal lashings in the past, and he did deliver a preemptive rejection of what Geithner is pushing Europe-and Germany specifically-to do:

Wolfgang Schäuble, Germany’s finance minister, has dismissed speculation about any Spanish request for eurozone support in buying its sovereign bonds, and ruled out making more concessions to help Greece, on the eve of talks on the eurozone crisis with Tim Geithner, US Treasury secretary.

The tough German resistance to launching any new initiative in the two most embattled member states of the eurozone looks set to clash with Washington’s constant appeal for action to stem contagion in the crisis.

Schäuble was on good behavior in the aftermath of his meeting with Geithner, and avoided the stinging rebukes he had delivered in the past.  Instead, the two limited themselves to exchanging banalities so light that it must have taken a large number of sandbags to keep them from soaring off into the heavens, like the Wizard of Oz.  They agreed that it would be a good thing to avoid a Eurozone crisis, and that everything should be done to achieve that:

The statement said that Messrs. Geithner and Schäuble “emphasized the need for ongoing international cooperation and coordination to achieve sustainable public finances, reduce global macroeconomic imbalances, and restore growth.”

The two stressed “the need for policy makers to adopt and implement all reform steps required to deal with the financial crisis and crisis of confidence,” while noting that top EU officials have said they will do whatever is necessary to fix the crisis.

Ah.  “Whatever is necessary.”  The new mantra.  Like what, specifically?  “Whatever is necessary.”  What is necessary?  “All reform steps required.”  What are those? “Whatever.” Whatever (in the snotty teen sense of the word) is right.

Sort of like saying that it would be a great idea to have fat free ice cream that tastes just like Hagen Dazs.  Pretty much everyone likes the idea, and definitely nobody has the slightest idea how to make it a reality.

ECB head Mario Draghi has gone out on a limb with his “whatever is necessary” promise.  Foolishly, a lot of investors have crawled out there with him.  I’m betting that Merkel, Schäuble, and Germany generally are going to saw it off, mainly because “whatever is necessary” to save the Euro is likely to impose crushing burdens on Germany that Germans will not accept.  I can’t see any mutually acceptable bargain here.  And certainly Timmy!’s and Obama’s hectoring isn’t going to make a bargain any more likely.

The impending closure of the ICE floor made me somewhat nostalgic-despite the fact I have long predicted that the floors were doomed, and I recognize that their demise is an example of creative destruction.  I like history, and get somewhat wistful when tangible connections to the past pass on.  In that frame of mind, I have been thinking of the many colorful accounts I have read of events on the floors in Chicago and New York.  In the late-19th and early-20th centuries, dramatic events on trading floors were covered by major papers in the news section.  Commodities were much more important then (in large part because a much larger fraction of the population and the economy was agrarian), and big moves in commodity prices-often the result of dramatic manipulation attempts-were front page news.

A case in point, from cotton (which I chose deliberately due to the ICE connection), is this article from the New York Times on May 19, 1903: “VIOLENT ADVANCE IN COTTON MARKET – New Bull Leader, Col. W.P. Brown, Here from New Orleans. May Option Reaches 11.68, July 11.26, and August 10.93.” (Confusingly, during this era-and even more recently, though less so-it was common to refer to “futures” as “options.”)  Scenes like this will not be seen again:

Before the hour of the opening arrived the pit was filled with a crowd of brokers seven rows deep.  Col. Brown [who was running a corner] was there also, and everybody kept a watchful eye on him . . . .

From that moment on until the gong sounded the close for the day the pit was one surging, seething mass of men, all of them excited and many of them evidently on the anxious seat.  They were all closely watching the man from New Orleans, who was supposed to be in the main responsible for the activity of the market.

A “surging, seething mass of men, all of them excited,” is already pretty much a thing of the past, as even the remaining pits are shadows of their former selves.

Google news archives can turn up some interesting articles in a similar vein.  So can some time spent looking at old editions of Chicago papers available in some databases, which covered the markets closely.  For a fictional treatment, Frank Norris’s The Pit (based fairly closely on the Leiter wheat corner) is excellent.

Though some things are changing, other things are enduring.  Like corners. Including, quite probably, in cotton.

The Intercontinental Exchange (not to be confused with the Intercontinental Railroad!) has announced the end of cotton, coffee, sugar, cocoa and OJ options floor trading.  The futures floor was closed some time ago.

The decision was spurred by the movement of options trading to ICE’s computerized trading system.  This is significant, and is likely the beginning of the end of floor trading.  Options have been the last major bastion of open outcry.  Many options trades involve more complicated multi-leg strategies (including spreads of various sorts) that are more difficult to computerize than simple outright futures trades, or simple futures strategies like calendar spreads, but which can be done efficiently on the floor: locals on the floors quote many of the common spreads.   If options can be done on the screens, there’s nothing really left for the floor to do.

Thus, we are witnessing the culmination of a process that began about 20 years ago.  I first did some research on electronic trading in the early-1990s, and remember the disdain with which the futures and options communities looked on computerized markets.  In 1995, I wrote a study comparing the electronic DTB and the open outcry LIFFE market which found that the former was as liquid, or more liquid than the latter: this study was met with much derision by LIFFE, and by most people in Chicago.  The derision of electronic trading died down substantially in 1998, when volume in the Bund futures market tipped completely to DTB’s successor (Eurex), and LIFFE suffered a near death experience.

The floor held out in the US for sometime longer, but by the early-2000s the writing was on the wall here as well.  By the mid-2000s options trading was keeping the floors going.  But that’s no longer true of ICE, and it is likely a matter of time before it is no longer true on CME/CBT or NYMEX.

Western companies with the misfortune of partnering in some way with Mikhail Fridman live in fear of the Tyumen Arbitration Court. Funny thing.  Holders of small positions in companies owned by Fridman that are in a battle with a western partner go to the Tyumen court to sue the western company for some breach, and ask for-and win-huge judgments.  The court has tortured Telenor for years.  And now BP is on the Tyumen rack:

A Russian arbitration court on Friday ordered BP BP.LN +1.39% PLC to pay just over 100 billion rubles ($3.1 billion) in damages to its joint venture TNK-BP in a suit bought by an investor, a ruling that the British company called a “corporate attack.”

“We will challenge today’s ruling in accordance with the procedure established by the law, and expect that the court of appeal will adopt a reasonable and fair decision,” BP said. “We consider this claim as an attempted corporate attack and believe that today’s ruling should be canceled.”

The ruling, from the arbitration court in Tyumen, is to take effect in 30 days unless appealed, in which case it would become effective at the end of the appeal process, BP’s lawyer said.

The order to pay damages comes amid rising tensions between BP and its partners in the 50-50 TNK-BP venture—a group of Soviet-born billionaires known as AAR. Earlier this week, BP said it was in talks to sell its stake in TNK-BP to state-run OAO Rosneft,ROSN.RS -10.01% a move that analysts said could put pressure on AAR, which is also bidding for the stake.

This is taking place against the background of maneuvering over the fate of TNK-BP, which appears to be developing into a The Good, The Bad, and The Ugly-like three way standoff between BP, AAR (in which Fridman is a partner and the strongest figure), and Rosneft.  (The only problem with that analogy is that none of these seems well-cast in the role of Eastwood’s The Good.  However, the the roles of “Bad” and “Ugly” are easily filled, and indeed the guy playing one could readily play the other.)

That contest is puzzling on many levels, and I have no idea what is going on.  Nor does pretty much anybody on the outside-and perhaps not so much on the inside either.  But the Tyumen court judgment gives Fridman leverage in this game.  Talk about home court advantage: nothing in sports comes close.

Iran is planning to sue Russia for $4 billion for failure to deliver S-300 missile systems worth less than $1 billion.  Russia’s response?  The usual truculence?  Surely you jest!  Instead, the Russians look ready to roll over:

By threatening exuberant compensation, Tehran hopes to blackmail Moscow into reconsidering its ban on selling S-300 missiles. This tactic seems to have been at least partially successful. Last week, the Kommersant daily quoted an unnamed government source that the Russian legal position in the coming litigation is weak, “the situation is serious” and “we fear that Russia may face a gigantic fine.” According to the director of the Center for Modern Iranian Research (a pro-Iranian think tank in Moscow), Rajab Safarov, Tehran hopes to provide Moscow with an excuse to present to the West: “Russia must fulfill the S-300 contract, or money will be lost.” The president of the pro-Kremlin PIR-Center think tank, Vladimir Orlov, believes Moscow made a serious mistake in canceling the S-300 deal under the pretext of sanctions: “The possible resumption of the S-300 contract has been and is being discussed in Russia; but if it will be resumed, the Iranian litigation will not be a factor.” According to Orlov, supplying Iran with S-300 missiles could “improve the situation in the region” by deterring the foes of Tehran. UN Resolution 1929 bans the sale to Iran of any “guided or unguided missiles” with a range over 25 kilometers. The S-300 – a potent long-range antiaircraft missile system – is not specifically mentioned in the UN resolution, and this is reported to be Tehran’s main argument in asking the Court of Arbitration in Geneva to rule the cancellation of the S-300 contract illegal (Kommersant, July 18).

Ah yes, Russia.  The land where contracts are sacrosanct.  A virtual religious obligation.

This is partly about money, but more about politics, and geopolitics.  Putin et al weren’t keen on Medvedev’s decision to submit to the sanctions:

In Moscow, the decision to ban the S-300 deal has been connected to Medvedev, but after Vladimir Putin took over the Kremlin, many decisions of the former president are either being overturned or postponed (Vedomosti, July 19). As relations with Washington continue to deteriorate over a constantly growing number of issues, the powerful pro-Iranian lobby in Moscow may hope it is time to overturn Medvedev’s “mistake” with the S-300s earmarked for Iran. Completing the sale would be very profitable and at the same time snub Washington. But an open violation of a UN embargo would damage Russia’s international reputation, so it remains to be seen whether or not the pro-Tehran lobby will indeed get its way. Russian policies continue to be as double-dealing as the S-300 is double-use.

The Syrian situation has ramped up antagonism between Russia and the US, and this leak could be a message about how Russia would respond if the Americans and the Europeans escalate the pressure on Assad.

And this whole setup seems just too pat, and therefore suggests some collusion between Iranian and Russian officials.  Iran sues for big money (wink, wink).  Russia responds (wink, wink): “Oh, we have such a pitifully weak case.  We have to live up to our contract in order to avoid paying Iran big money.  After all, a contract is a contract.  You see, all the arms we are currently delivering to Syria now were contracted for years before.  So international pressures or no, we have to perform.”

Given the fraught situation in the Middle East, adherence to contracts is the least important aspect of the S-300 issue, especially for a country like Russia that is past master at fighting judgments in international forums.  This lawsuit and the Russian response to it is a Kabuki act intended to send a signal to the US and the Europeans to back off Syria and Iran.

Timmy! is deeply offended by SIGTARP Barofsky’s assertion that he was too close to Wall Street while he was head of FRBNY. In related news, Geithner defended himself against allegations that he had not been sufficiently aggressive in his handling of the LIBOR situation:

“We, at least I, first learned about those concerns in the early parts of spring of 2008 and we acted very quickly at that stage. At that time, this is in the spring of 2008, we took a very careful look at these concerns, we thought those concerns were justified,” Geithner said.

“And we took the initiative to bring those concerns to the attention of the broader U.S. regulatory community, including all the agencies that have responsibility for market manipulation and abuse,” he said, citing a specific meeting of the president’s working group on financial markets.

Note this:

The first trove of documents from the New York Fed showed that Barclays had flagged concerns as early as 2007 and Geithner sent the email to Bank of England Governor Mervyn King in June 2008 with the Libor recommendations.

So let’s review the timeline:

• In August, 2007 Barclays admits to FRBNY personnel that it submitted misleading LIBOR quotes, and claims that this practice is widespread.
• In April 2008 the WSJ runs an article providing evidence that banks were systematically underreporting LIBOR rates.
• In June 2008-AFTER the WSJ article-FRBNY sends a letter to the BOE suggesting procedural and governance changes to LIBOR in order to reduce the incentive to misreport.  This letter says nothing about Barclay’s admission that it had in fact misreported LIBOR 10 months earlier.
• BOE does nothing.  FRBNY does nothing.  FRBNY does not follow up when BOE does nothing.

So I guess we now now what “all I could” means in Timmyspeak.

I would have more respect for Geithner had he said: “Given the state of the banking system it would have been catastrophic to pursue aggressively misreporting of LIBOR.” The weaseling-not so much.  That is truly offensive.  (The “We, at least I, first learned” weaseling is particularly offensive.  Just where did the buck stop at FRBNY?)

Incidentally, the NYT has turned on Geithner for his role-or lack thereof-in cracking down on the misreporting.  Moreover, it has come out in support of Gary Gensler as a replacement for Geithner, in the event of a 2d Obama term:

And when the time comes to choose a new Treasury secretary — Mr. Geithner has said he does not expect to remain if President Obama is re-elected — the next president would do well to look for candidates among the regulators who have distinguished themselves by their willingness to confront the banking system’s manifest problems. One such person is Gary Gensler, the chairman of the Commodity Futures Trading Commission, which pursued the rate-rigging allegations against Barclays, securing a record fine and referring the matter to the Justice Department for criminal investigation.

A couple of things.  First, the CFTC acted almost five years after the initial information came to light: that’s confrontation?  Second, has the NYT maybe like heard of MF Global?  Peregrine?

Admittedly, a Gensler Treasury would probably be well down on the list of debacles in the event of Obama’s reelection.  But a debacle it would be, and the LIBOR case-in which the CFTC worked with DOJ and the BOE-is hardly sufficient grounds to justify Genlser’s elevation, especially in light of the two confidence-shattering, and unprecedented, breaches of customer fund segregation that occurred on his watch.

But then again, DC has always been a living, breathing, pulsating embodiment of the Peter Principle, so it just might happen.

That the European Bank for Reconstruction and Development believes that Russia is anything but “an island of stability”, being instead a high beta economy that will suffer substantially if the crisis in Europe worsens:

Russia’s economy is more vulnerable to the effects of the euro zone’s fiscal and banking crises as commodity prices fall, the European Bank for Reconstruction and Development said Wednesday.

Starting in October, the EBRD slashed growth forecasts for eight economies in Central Europe, or CEB, and the Baltics and seven economies in Southeastern Europe, or SEE, citing their close trade and financial links to the euro zone.

With strong growth elsewhere in the global economy supporting prices for oil and other raw materials, the EBRD’s forecasts for Russia were largely unchanged. But in its latest report on the outlook for the economies in which it invests, the bank said the impact of the currency area’s prolonged crisis will spread further east and drag Russia down.

“The negative spillovers are reaching east, and to Russia in particular through two main channels: lower commodity prices and a general reduction in risk appetite,” said Piroska Nagy, the EBRD’s director for country strategy and policy.

You can see the channels work in real time.  Right now oil is being buffeted by two conflicting forces: developments in the Eurozone involving primarily Spain and Italy, and developments in the Middle East involving Iran and Syria.  Bad (good) news about the situation in Spain drives down (up) the price of oil; increased (reduced) fears that Iran will do something aggressive in the Straits of Hormuz drives up (down) the price of oil.  And the Russian stock market and the ruble move nearly in lockstep with these movements.

The EBRD is not alone.  Maplecroft, a political risk think tank, also believes Russia’s economic fate depends on what transpires in the Eurozone:

Countries in central Europe and Scandinavia as well as commodity-exporting African countries Ivory Coast and Mozambique are also among the 17 economies classed as being at “extreme risk”, while the BRICs quartet of big emerging market nations Brazil, Russia, India and China is also highly exposed, the survey showed.

. . . .

Arab Spring countries Tunisia, Egypt and Libya follow closely behind, while Russia, Brazil and India were also tagged with a high exposure to the euro zone crisis.

Of the BRIC group of major emerging countries only China was ranked with no more than a medium exposure to the euro zone.

In other words, Russia will suffer substantially if things go pear shaped in Spain (as they are likely to do, IMO, given the daily blob like growth of the problem with regional bailouts, bank problems, and a looming deepening of the recession), without the consolation of pleasant weather and nice beaches.

Near zero interest rates are wreaking havoc among FCMs. I recall reading something about that.  Heck, I remember writing something about that about a week ago.

There is a puzzle here, though.  Why don’t commissions vary inversely with interest rates?  The FCM business is pretty competitive, meaning that FCMs should earn the competitive rate of return, i.e., roughly speaking revenues should equal costs plus a fair return on capital.  If interest rates rise, generating more revenues for FCMs, competition should lead them to cut commissions in order to attract customers.  Conversely, if interest rates fall, reducing FCM revenues, competitive pressures should induce them to raise commissions.  Why have commissions remained at rock bottom levels despite the loss of revenues from interest on customer funds that the FCMs hold and invest?

One possible explanation is that due to technological change (e.g., the expansion of electronic trading) there is excess capacity in the FCM industry, and some firms should exit.  The excess capacity keeps downward pressure on commissions, which will not rise until there is a significant shakeout.

Perhaps MF Global, or Peregrine, or both, were unwilling to concede that they were no longer economically viable and should exit.  Frequently the need to secure external funds to keep operating is what forces unviable businesses to exit even though individual managers or owners may want to try to gamble or cheat for resurrection.  Financial firms’ (including FCMs’) ready access to cash (even if it isn’t really theirs) can permit them to engage in these sorts of actions without securing external funds.  This is why financial sectors under stress are particularly vulnerable to fraud and excessive risk taking: not only do stressed firms have the incentive to engage in this kind of conduct (which is true of stressed firms in other industries too), but they have opportunities that stressed firms dependent on external finance do not.

I am in Ben Bernanke’s home town, Columbia, SC.  (Psst.  Don’t tell anyone that my great-great-great-great uncle helped burn the place down in February, 1865.)  No, I am not making a pilgrimage to Ben’s birthplace.  I am on a mini-vacation with my dad, visiting some historical sites.

Today we visited the Ninety Six National Historical Site.  You have to want to go there, because it’s not on the way to anywhere.  At least now.  Back in the mid-18th century, it was a fairly important place, because it was on the way between Charleston and the Cherokee lands to the west.  The most common explanation of the name is that the settlement was 96 miles from the Cherokee town of Keowee, but only per the measurements of a drunken surveyor: the actual distance is in the mid-80 mile range.

Ninety Six was the site of bookend battles in the American Revolution.  It was the location of the first major action in the South, in November 1775.  It also saw a major battle a few months before Yorktown, when Nathaniel Greene (the most underrated general in American history) unsuccessfully besieged the place in May-June, 1781 before being driven off by a relief force under General Rawlinson.  All the combatants on both sides in both battles were Americans: the war in the South was a civil war, with all of the bitterness and horror that entails.

Most Revolutionary War sites are underwhelming.  The battles were small, with a few thousand on each side even in the bigger battles.  The siege at Ninety Six involved less than 2000 combatants.  The combatants didn’t mark the fields, as was done with big engagements in the Civil War.  Some battlefields are dimly understood: the general locations are known, but lack of documentation makes it impossible to know precisely what happened where.  So sometimes visiting a Rev War site is about as interesting as looking out into your back yard, or visiting a local park.

Ninety Six is an exception.  The site contains one of the best preserved earthworks from the War: the British “Star Fort” that Greene (and his chief engineer, Thaddeus Kosciusko) unsuccessfully besieged.  There are remnants of the American sap trenches and parallels, the last of which was within a stone’s throw of the fort.  The Americans were so close you would think they could have taken the place in a rush, but obstacles including abattis (interlaced tree branches) and chaveaux des frises (sharpened stakes) and a moat/ditch slowed attackers: a forlorn hope attack by 60 Americans was beaten back with 50 percent casualties.  There is also the remnants of a mine that the Americans were digging under the work, but which they abandoned when Rawlinson’s Rawdon’s army approached, lifting the siege.

The Park Service has also reconstructed the palisade fort where the 1775 battle took place.  Everything is well marked, and pristine: civilization really does not encroach, so the visitor can get a feel for what it was like in 1775 or 1781. The visitors’ center has a nice 20 minute film.  NHS and NBP films are highly uneven: some are truly cringeworthy.  But the Ninety Six film is quite well done (except for the ahistorical exploding shells: the artillery used in the battles was capable only of firing solid ammunition): it won an award at a Houston film festival last year.  The staff is also cheerful and helpful.

There are few Revolutionary War battlefields I think worth an extended visit.  Ninety Six is definitely one of them.  It is out of the way, but if you are in western NC (where my parents live) or western or central SC it is worth a trip.  Especially if you can go with your dad.

Here are a couple of pics. The first is a view of the last American parallel (and the site of sharpshooter’s tower) from the rampart of the fort.

The second is a view of the fort (in the background) with the American saps and parallels in the foreground.